Tag Archives: #Powell

Clueless

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The risks to our mandates appear
More balanced so let us be clear
We’re still cutting rates
Which just demonstrates
We’re clueless and shaking with fear

 

To absolutely nobody’s surprise, the Fed cut the Fed funds rate by 25bps yesterday.  The accompanying statement explained, “The Committee judges that the risks to achieving its employment and inflation goals are roughly in balance.”  The implication is that they remain confident that inflation is slowly heading to their 2.0% target, and they are keeping a close eye on the Unemployment Rate, especially after the terrible number last week.  Of course, the combination of the Boeing strike and the impact of the two major hurricanes, Helene and Milton, were likely responsible for a significant portion of that underperformance, so we will need to see how the November report, published on December 6th plays out.  There is a lot of time between now and then so the narrative could easily change prior to the release.  Be vigilant.

The press conference consisted of a lot of self-congratulatory comments about how they have done a good job “recalibrating” policy and continuing to insist inflation is dying, although not quite dead yet.  The market response was to continue the US equity rally, with the NASDAQ (+1.5%) leading the way higher and to reverse some of yesterday’s bond losses with 10-year yields slipping -8bps.  In the commodity markets, yesterday saw all of them rebound, recouping roughly half of their losses from Wednesday and the dollar gave back some of those initial gains as well.

At this stage, the market is pricing a two-thirds probability of another 25bp cut at the December meeting, and all eyes are now going to turn to Trump and whatever policy prescriptions he starts to tout.  The early indication is that people expect more growth in the US from his policies as the no-landing scenario seems to be the favorite.  We shall see.

Investors had high hopes that Xi
Would give away more renminbi
Instead, in a flop
They’ve spurred a debt swap
While stimulus, no one can see

The other story of note overnight was the final statement of the Standing Committee in China, where many had expected hoped the elusive Chinese Bazooka would be fired.  It was not.  Instead, they gave more details on an effective debt swap that they will permit for local governments.  

A brief tutorial: Chinese cities and regions had typically financed infrastructure investment via local government funding vehicles (LGFV) which issued debt to investors that was backed by the government entity, but not officially on their balance sheet.  This model evolved because there were restrictions on how much debt these cities/regions were allowed to issue.  These entities would then sell land to developers to service and pay off the debt.  It all worked great while the property bubble in China was inflating and nobody was the wiser.  But now that property prices have been falling for 3 years, it is a major problem because the cities/regions aren’t generating the property sales and revenues needed to repay the debt.  

The solution that Xi came up with is to allow the cities/regions to issue debt on the balance sheet, upwards of CNY 10 trillion over the next 5 years, and replace the off-balance sheet stuff from the LGFVs.  And that’s it!  A debt swap that will likely lower interest rates slightly and save somewhere along the lines of CNY 600 billion over 5 years.  While the central government claims there is only a total of CNY 14.3 trillion in these LGFVs, most analysts put the number at around CNY 60 trillion.  This is not really that stimulative, will not help Chinese consumers nor factories in any way, and is very likely to have only a tiny impact. 

Cagily, the Standing Committee didn’t announce this until after local markets closed for the weekend, so the fact that stocks on the mainland and in Hong Kong only fell -1.0% does not represent the totality of the disappointment.  I expect we will see further declines next week.  President Xi has some tough sledding ahead for his economy.

And that was really the news of note.  Literally everything else you can read is a post-mortem of the election.  So, let’s look at how markets behaved overnight.  Away from the Chinese share declines, there were more winners than losers in Asia, with those nations that seem to have closer ties to the US benefitting (Taiwan, Australia, Singapore, New Zealand) while others which are more neutral or in China’s sphere of influence under pressure (India, Thailand, Vietnam).  The other noteworthy news was that the Chinese Current Account hit its second highest surplus ever last month, but with most people expecting significant tariff implementation when Trump takes office in January, I suspect those numbers will decline.  

Meanwhile, European bourses are almost entirely under water this morning with most lower by -0.9% although Spain’s IBEX is unchanged on the day.  There hasn’t been much in the way of new data, and I sense that investors are starting to price in more difficult relations with the US now that it seems clear the Republicans will win the House as well, giving Trump the ability to implement his vision.  Meanwhile, at this hour (6:50) US futures are little changed, consolidating ahead of the weekend.

In the bond market, yields which backed off in the wake of the FOMC meeting yesterday have edged 2bps lower this morning and are now sitting at 4.30%. This is the level, when first reached a week ago, set hair on fire as to the dichotomy between the Fed cutting rates and longer-term yields rising.  My view continues to be that yields have higher to climb over time as the Fed’s inflation fight is not won, and it will become evident that is the case going forward.  As to European sovereign yields, they are all lower by -4bps this morning as they are simply following Treasury yields but had to catch up given the FOMC meeting occurred after their close yesterday.

In the commodity markets, it appears that nobody wants to own ‘stuff’ anymore as they are back under real pressure.  Oil (-1.4%) is sliding although that makes sense as a Trump administration is very likely to support as much production as possible thus increasing supply.  But metals prices are also under pressure (Au -0.5%, Ag -1.5%, Cu -2.2%) which makes less sense as if economic expansion is the view, I would expect these to perform well.  Of course, it is possible that this is a reaction to the damp squib from China last night, but I expect these items to gradually regain lost ground.

Finally, the dollar is gaining some strength this morning, rising against most of its G10 counterparts with AUD (-0.6%) the worst performer, although JPY (+0.5%) and CHF (+0.2%) have managed to climb.  It’s almost as if this is a classic risk-off scenario in the FX markets.  Certainly, EMG currencies are under pressure this morning with ZAR (-1.1%) the laggard, but declines across the board, notably CNY (-0.3%) and pushing back toward the 7.20 level.  But the dollar is strong everywhere in this bloc.  

On the data front, Michigan Sentiment (exp 71.0) is all we get this morning although we also get our first Fed speaker, Governor Bowman, who has been one of the more hawkish voices.  One other thing to note is that the FAO’s Food Price Index was released this morning, climbing 2% to 127.4.  as you can see from the chart below, while this is not as high as prices reached in the immediate aftermath of the Russian invasion of Ukraine, this level is still in the upper echelons of where things have been over the past thirty-four years.

Source: tradingeconomics.com

It is worth remembering that the Arab Spring in 2011 was partially driven by rising food prices with large scale protests upending several governments.  Given how unhappy people around the world have been with their leadership, as evidenced by the number of governments that have been kicked out of office in recent elections and given that rising food prices have been a constant complaint, this needs to be kept in mind for how events unfold in the future.  To me, the market implication is that more volatile politics around the world will feed into more volatile financial markets as uncertainty grows.  In times of stress, the dollar remains the haven of choice, so this is just another reason to keep looking for the dollar to outperform in the medium term.

Good luck and good weekend

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Erring

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Excitement does not quite portray
The thirst for risk shown yesterday
Though media cried
Investors took pride
In Trump, sure that he’ll save the day
 
So, next Chairman Jay and the Fed
Will try to explain that instead
Of further rate paring
They might soon be erring
On side that Fed rate cuts are dead

 

Wow!  That is pretty much all one can say about yesterday’s equity market response to the confirmation that Donald Trump will be the next president of the United States.  The DJIA rose 3.6%, far outpacing both the S&P 500 (+2.5%) and the NASDAQ (+3.0%) but even that paled in comparison to the Russell 2000 small-cap index which jumped nearly 6% on the day!  Investors are all-in on the idea that Trump will seek to bring home as much manufacturing and economic activity as possible via tariff policies and small caps and old-line companies are the ones likely to benefit.

But boy, bonds had a tough day with yields across the curve rising between 10bps (2yr) and 20bps (30yr) with the 10yr gaining 15bps on the day.  It is all part of the same mindset, higher economic activity and no slowdown in spending leading to rising inflation and, correspondingly, rising yields.

The other area that really suffered were the metals markets, with gold (-3.3% or $90/oz), silver (-4.7%) and copper (-5.0%) all getting hammered.  The best explanation for the gold price’s decline I have heard is the idea that with Trump coming into office, the prospects for a nuclear war have greatly diminished.  Certainly, based on the fact that there were no new wars during his last term and one of his promises is to end the Russia/Ukraine war on the first day, perhaps that is correct.  As well, consider that the dollar exploded higher, something which had lately been a benefit for metals, but historically has been a negative, and at least we can make some sense of things here.

So, where do we go from here?  That, of course, is the $64 billion question.  Reactions around the world are still coming in and I would characterize them as a mix of stoicism and fear.  Perhaps a good place to start is Germany where the governing coalition just collapsed as Chancellor Sholz fired the FinMin who was the head of the FDP, one of his coalition’s groups.  Their problem is that the German economic model is crumbling, and the population is unhappy with the current situation.  The former can be demonstrated by today’s data showing the Trade Surplus fell more than expected while IP fell back into negative territory again, an all-too-common occurrence over the past three years as can be seen below, and hardly the best way to improve the productivity of your economy.

Source: tradingeconomics.com

Meanwhile, politically, the country is seeing a widening of views across the spectrum with the combination of the anti-immigration parties, AfD on the right and BSW on the left, garnering support of about 25% of the population and preventing any meaningful coalitions from being formed.  

If Germany continues to lag economically, it will negatively impact the whole of the Eurozone.  The divergence between the US economy, which has all the hallmarks of faster growth ahead, especially under a new administration, and the European economy, which continues to struggle under a suicidal energy policy that undermines any chance of industrial resurgence, and therefore a significant rebound in economic activity could not be greater.  While much ink has been spilled regarding the prospects that the dollar is going to collapse because of the debt situation and the BRICS are going to create something to replace it, the reality is the euro is in far more dire straits.  The ECB is going to be much more aggressive cutting rates than the Fed and the market is starting to price that in.  The below chart from Bloomberg this morning does an excellent job showing the change in market pricing over the past month.  

I find it hard to see how the euro can benefit in this environment regardless of the dollar’s performance against other currencies given the more limited economic prospects on the continent.  They are dealing with an existential crisis because of Russia’s more aggressive stance since the invasion of Ukraine combined with an undermining of their economic model which was based on exporting high value items to China and the rest of the world.  The problem with the latter is China has become a huge competitor and a shrinking market for their wares, and they have limited other markets.  If Trump holds to his word and imposes 20% tariffs on European imports to the US, the euro is likely to fall even further.

That is just a microcosm of one area and its response to the US election, but one that may well be a harbinger for many others.  The US stance in the world is changing and other nations are not really prepared.  Expect more financial market volatility, in both directions, as these changes become more evident and play out over time.

Ok, let’s see how other markets behaved with confirmation of the Trump victory.  In Asia, the Nikkei (-0.25%) slid but other indices rallied indicating a mixed picture.  Meanwhile Chinese shares rallied sharply (CSI 300 +3.0%, Hang Seng +2.0%) as expectations grow that the Standing Committee will expand the stimulus measures in the wake of the election.  Remember, the Chinese had delayed this annual meeting by a week to capture the results of the US election and now traders are betting on a bigger response.  As well, the Chinese Trade Surplus expanded far more than forecast, to its third highest monthly reading of all time at $95.3B.  As to the rest of the region, the picture was very mixed with some gainers (Singapore +1.9%, Taiwan +0.8%) helped by the China story and some laggards (India-1.0%, Philippines -2.1%) with the latter suffering from a much weaker than expected GDP report.

In Europe, interestingly, most markets are performing well this morning led by the DAX (+1.3%) although the rest of the continent’s bourses are only higher by around 0.5% or so.  The laggard here is the FTSE 100 which is unchanged on the day in the wake of the BOE’s widely expected 25bp rate cut.  Although, there were apparently some looking for a 50bp cut as stocks fell a bit in the wake of the news and the pound jumped 0.3%, a clear sign of a minor surprise.

Speaking of currencies, the dollar which has had quite a run in the past two sessions is backing off overall this morning although remains well above the pre-election levels.  In the G10, NOK (+1.3%) is the leader as the Norgesbank left rates on hold and indicated that was likely their stance going forward, while AUD (+1.0%) seems to be benefitting from both the rebound in metals prices and the potential Chinese stimulus.  Otherwise, currencies have rallied between 0.3% and 0.5% in this bloc.  In the EMG space, ZAR (+1.4%) is the biggest gainer, also on the precious metals rebound, while MXN (+1.2%) is next, although that is simply a continuation of the retracement from the post-election decline.  Bigger picture, I think the dollar remains well bid, but not today.

In the bond market, Treasury yields are unchanged this morning, consolidating their gains from the past week and waiting for the Fed this afternoon.  However, European sovereign yields have all rallied substantially, between 6bps and 9bps, which looks, for all intents and purposes, like the continent’s catch-up trade to yesterday’s US movement.  Nothing has changed the view that Treasury yields lead bond market moves in the G10.

Finally, in the commodity space, oil (-1.0%) is a bit lower this morning although yesterday it recouped most of its early losses and closed lower only minimally.  Yesterday also saw a surprising inventory build in the US which would be expected to weigh on prices.  In the metals markets, after a virtual collapse yesterday, this morning is seeing stabilization in precious metals and a sharp rebound in copper (+2.3%) as hopes for that Chinese stimulus spread to this market as well.

In addition to the FOMC meeting this afternoon, we see regular Thursday morning data of Initial (exp 221K) and Continuing (1880K) Claims as well as Nonfarm Productivity (2.3%) and Unit Labor Costs (1.0%).  However, despite all the recent activity, and the fact that a 25bp cut is a virtual certainty, Chairman Powell’s press conference will still have the trading community riveted to see how he describes any potential future paths in the wake of the election results.  Given the recent data and the estimate prospects of a Trump administration’s efforts to goose growth further, it is hard to see how the Fed can really discuss cutting rates much further.  In fact, I will go out on a limb and say I expect forecasts of the neutral rate are going to consistently climb higher and reach 4% before the end of 2025.  And that means, as is evident by both the economy and the stock market, the Fed has not tightened financial conditions very much at all.

Good luck

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Open and Shut

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The FX Poet will be in Nashville at the AFP Conference October 21-22, speaking about effective ways to use FX options in a hedging program.  Please come to the presentation on Monday at 1:45 in Grand Ballroom C2 if you are there.  I would love to meet and speak.
 
The great thing about recent data
Is nobody thinks it will matta
It’s open and shut
The Fed’s gonna cut
As ‘flation ambitions they shatta
 
In Jay’s mind, the risk tradeoff’s clear
As stocks work to find a new gear
However, for debt
They’re making the bet
The problems won’t hit til next year

On this Columbus Day holiday, US cash markets are closed although futures are trading, so no stock or bond market activity today.  The FX market will be open, as always, although I suspect liquidity will be less than usual, especially once Europe goes home at noon so hopefully, you don’t have much to do today in the way of hedging.

As it happens, there was not a lot of news overnight to discuss, although China did manage to once again disappoint with respect to their fiscal support announcement on Saturday, not offering up even a big picture number, let alone specific programs, that they are considering.  Interestingly, this did not deter the new China stock bulls, with the CSI 300 (+1.9%) rallying sharply, but this is becoming a sentiment story, not a data driven one.  Someone on X asked the question about why Xi was not doing more, and my view has become that he recognizes to truly get the economy going again he will need to cede some of the power he has spent the past 10 years amassing.  I sincerely doubt he is willing to do that, and since his life won’t change regardless of the amount of stimulus, in the end, holding power is far more important to him.

But let’s go back to the data driven approach and its pluses and minuses.  This morning’s WSJ had an articleby James Mackintosh titled, “The Fed Has a Dependency Problem That Needs Fixing”, and it is his view that data dependence is the current Achilles Heel for Powell and friends.  Now, I won’t dispute that the market’s tendency to extrapolate one data point out to infinity can have market consequences, but I think the point Mr Mackintosh misses is that this is a problem entirely of the Fed’s own making.  Nobody instructed them to offer their views, other than the semi-annual testimony before Congress.  Nobody is forcing FOMC members to be out blathering virtually every day (in fact, two of them, Waller and Kashkari, will be speaking today despite markets being closed).  Forward Guidance was Benny the Beard’s brainstorm, it is not a Congressional mandate, it is not in the Fed’s charter, it is entirely their own.

So, if too much forward guidance is a problem, the Fed can simply stop it.  There is no doubt the recent data releases have been somewhat confusing, with more strength than most economists and analysts have forecast, and there is no doubt that any given month’s data point is subject to certain random fluctuations and revisions.  However, consider if the Fed was not trying to guide the market to whatever their preferred outcome may be.

If there was no Forward Guidance, then each individual investor would have to analyze the current situation themselves, get their best estimate of how they anticipated the future to evolve, and position themselves accordingly.  In today’s world, there is a lot of data pointing in different directions.  Absent the Fed trying to sway opinion, position sizes would be greatly reduced, and the large reversals in markets like we saw in the wake of the recent rate cut and subsequent NFP and CPI releases, would likely be far less significant.  

When the Fed explains that they are going to keep rates lower for longer (as they did in the wake of the GFC and again post covid) that is a clear signal to investors to load up on assets that perform well in a low-rate environment (i.e. stocks).  When they change that view…oops!  That is what we saw in 2022 when they flipped the script and went from transitory inflation to persistent inflation.  Everybody who was long both stocks and bonds suffered.  

But let’s run a thought experiment.  If the Fed gave no Forward Guidance, and merely adjusted rates as they saw fit, investors would have had significantly less confidence that regardless of what had clearly become an inflation problem, the Fed was going to maintain low interest rates.  There would have been a much more gradual move out of risk assets as investors determined inflation was a problem, and the Fed wouldn’t have had all that egg on their face when they had to admit they made a mistake about inflation.

In the end, I disagree with Mackintosh that the Fed should essentially ignore the data, but I agree that they shouldn’t talk about it at all.  In fact, I think we would all be far better off if none of them ever said a word!

Enough of my diatribe.  Let’s see how the rest of the world’s markets behaved overnight.  While mainland Chinese stocks performed well, Hong Kong (-0.75%) did not.  Japan was closed for National Sports Day, although the broad Asia look was that markets there followed Friday’s US rally as well.  However, this morning in Europe, the picture is mixed with some gainers (DAX, IBEX) and some laggards (CAC, FTSE 100) and none of the moves more than 0.3%.  The only data overnight was Chinese Trade (reduced Trade surplus of $81.7B) and Chinese financing which was modestly disappointing despite the recent efforts at goosing things there.  US futures are trading this morning and at this hour (7:00) they are mixed with modest gains and losses of ~0.25%.

With Japan closed along with the US, it should be no surprise that bond market activity is extremely limited with yields essentially unchanged this morning from where they were at Friday’s close.  However, remember that 10-year Treasury yields are higher by nearly 50bps since the day before the FOMC meeting.  This is an important signal that market participants are far more concerned about inflation than the Fed.  On this subject, I think the market is correct.

In the commodity markets, oil (-2.4%) continues its recent decline as the long awaited and feared Israeli response to Iran’s missile attacks seems to have been postponed further.  The absence of that supply concern alongside the lack of Chinese stimulus, and by extension demand, has weighed heavily on the market.  Gold is unchanged this morning although we are seeing some softness in the industrial metals with both silver and copper softer today.

Part of that metals weakness is due to the fact that the dollar continues to rise against all forecasts.  This weekend there was a meeting of the old Soviet nations, the CIS (absent Ukraine of course) and they pledged to stop using dollars in their trade.  This is in the lead-up to the BRICS conference to be held next week in Kazan, Russia, where once again many claim that this group of nations will create their own currency in their efforts to get away from the dollar’s hegemony.  Whether or not they formally do so, I have yet to see a path that includes a cogent rationale for anyone to use this currency, especially if it is backed by a series of nonconvertible currencies like the CNY, BRL and INR.  But it does generate clicks in the doomporn sphere.  

But back in the real world, the dollar is just grinding higher vs everything this morning with NOK (-0.8%) suffering on oil’s weakness and AUD (-0.5%) and NZD (-0.5%) under pressure because of metals weakness and lack of Chinese stimulus.  ZAR (-0.8%) is also feeling the metals weakness but JPY (-0.4%) and CNY (-0.35%) are all softer this morning.  In other words, it is business as usual.  In fact, for those of you with a market technical bias, a quick look at the euro chart seems to define the concept of a double top.

Source: tradingeconomics.com

On the data front, aside from loads more Fedspeak this week, and the ECB monetary meeting on Thursday, the big data print in the US is Retail Sales, also on Thursday.

TuesdayEmpire State Manufacturing2.3
ThursdayECB Rate Decision3.25% (current 3.5%)
 Initial Claims255K
 Continuing Claims1870K
 Retail Sales0.3%
 -ex Autos0.2%
 Philly Fed3.0
 IP-0.1%
 Capacity Utilization77.8%
FridayHousing Starts1.35M
 Building Permits1.45M

Source: tradingeconomics.com

Adding to today’s Fedspeak, we hear from eight more speakers this week. With the Fed funds futures market pricing a 14% probability of no cut at all in November, which would be remarkable given the 50bp cut they made last month, it strikes me that there will be very little new from the speakers.  Rather, if the data this week comes in hotter than forecast, that is going to be the market driver.  I think it is fair to say the Fed has made a hash of things lately.  As long as the data continues to look good, though, I have to believe that fears of renewed inflation and higher rates are going to support the dollar.

Good luck

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Clouded and Blurry

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The Minutes explained twenty-five
Would likely still let markets thrive
But Powell demanded
A half, lest they landed
The ‘conomy in a crash dive

 

Yesterday’s release of the FOMC Minutes was enlightening to the extent it showed Chairman Powell did not have everybody in agreement for his 50bp rate cut last month.  In the Fed’s own words, “…a substantial majority of participants supported lowering the target range for the federal funds rate by 50 basis points to 4-3/4 to 5 percent.  However, noting that inflation was still somewhat elevated while economic growth remained solid and unemployment remained low, some participants observed that they would have preferred a 25 basis point reduction of the target range at this meeting, and a few others indicated that they could have supported such a decision.”  

Remember, too, that this meeting was held two days prior to the NFP report which changed a great deal of thinking on the subject, not least by the Fed funds futures market which as of this morning is pricing a 20% probability of no cut at the November meeting.  Looking at the GDPNow calculation from the Atlanta Fed, that NFP number increased the estimate to 3.4%, although recent inventory data has seen it slip back a tick as you can see below.  

Source: atlantafed.org

Despite that last little dip, though, the estimate remains far stronger than economists’ forecasts and paints a picture of a resilient economy.  (Perhaps adding $1.8 trillion via the budget deficit has something to do with that, but that is a story for a different time.). While the Fed is clearly anxious, if not desperate, to cut rates further, the economic case, with inflation remaining above their targets and the employment situation looking better amid solid economic growth, seems to be waning.

Three weeks ago, Jay and the Fed
Said joblessness was their, flag, red
Explaining inflation
Had taken vacation
So, more cutting rates was ahead
 
This morning we’ll learn if that’s true
Or if, like employment, their view
Is clouded and blurry
Which could cause some worry
For bulls and for Biden’s whole crew

Which leads us to the other key market story today (clearly the devastation from Hurricane Milton is the most important news of the day and my thoughts and prayers go to all those in its path), the CPI report.  Current consensus expectations are for a 0.1% rise in the monthly headline reading which translates to a 2.3% Y/Y increase and a 0.2% rise in the monthly core reading which translates into a 3.2% Y/Y increase.  

Looking at some obvious pieces of the puzzle, gasoline prices fell 8.4% in September, which is one of the reasons the headline number is below the core number.  The thing is, gasoline prices this morning are almost exactly where they were at the beginning of September, which informs us that the headline number could easily retrace somewhat next month.  The point is, we need to keep our eye on the core number (after all, the reason they created it was because food and energy prices were volatile and monetary policy’s impact on them virtually nonexistent, so they needed something that might give them a better feel for the reality elsewhere).  And I don’t know about you, but if the target is 2.0% then 3.2% doesn’t seem that close.  I know they are focused on core PCE, but even that remains well above their target.

One of the stories around this morning is that used car prices have stopped declining and that could have an outsized impact resulting in a higher than otherwise reading.  But in reality, I question whether this matters at all.  What we have learned from the Fed over the past month is that they are going to cut rates no matter what.  While the pace of those cuts may be faster or slower depending on some data, every Fed speaker this week, and even a review of the Minutes, points to the fact that they are all desperate to keep cutting rates.

But you know who is taking exception to that stance?  The bond market.  Perhaps the bond vigilantes of late 90’s fame have been resurrected, or perhaps investors are simply looking at the fiscal situation in the US, where deficit spending continues to increase which means more and more Treasury debt will need to be issued and decided that even 4.0% is no longer a reasonable nominal return on their investment.

As you can see below, 10-year Treasury yields have risen 46bps since just before the last FOMC meeting as the stronger US data combined with the Fed’s clear focus on cutting rates has made investors nervous.  

Source: tradingeconomics.com

You may recall the discussion about the inverted yield curve, where 2yr yields traded above 10yr yields for more than two full years, a record amount of time.  This fostered many recession calls as historically this has been a harbinger of a future recession.  However, a key question was whether the disinversion would be a bull (falling 2yr yields) or bear (rising 10yr yields) steepener.  Things started as a bull steepener with the Fed cutting rates, but lately, as we watch 10yr yields rise, fears are growing that inflation is making a comeback and the bond bears are going to drive this process.  A bear steepening is not going to be a welcome result for Powell and friends, nor especially for Ms Yellen, as the cost of debt will continue to rise.  It also speaks to concerns that the Fed has lost control of the narrative.  It is still too early to declare the outcome, but the original, widely held view of a bull steepener is fraying at the seams.

Ok, let’s quickly touch on overnight markets.  Yesterday’s US rally saw follow through in Japan (+0.25%) alongside a weakening yen (-0.75% yesterday, +0.2% this morning) and in China (+1.1%) and Hong Kong (+3.0%) after the PBOC detailed the support they would be giving to equity market players and indicated that more could follow.  As to the rest of the region, there were more gainers than laggards but nothing of real note.  In Europe, although most markets are little changed on the day, if leaning slightly lower, Spain’s IBEX (-0.9%) is the outlier on what seems to be profit taking ahead of the US CPI number after a strong 5-day run higher.  And at this hour (7:10) US futures are pointing slightly lower, about -0.2%.

In the bond market, yields continue to climb around the world with Treasuries adding 1bp and most of Europe seeing yields rise 2bps – 3bps.  The largest mover there, though is the UK (+6bps) as the market there prepares for Chancellor Rachel Reeves’ first budget and implies they are not expecting fiscal prudence.  In Japan, JGB yields rose 2bps and are now at 0.94% as given the turnaround in rates globally, expectations are growing for the BOJ to consider another hike.  In fact, ex-BOJ member Kazuo Momma was quoted last night saying that if USDJPY goes back above 150, the BOJ is likely to move before the January meeting currently expected.

Commodity markets are taking a breather from their recent rout with oil (+1.4%) leading the energy group higher while gold (+0.4%) leads the metals complex.  It has been a rough week for commodity bulls (this poet included) but nothing has changed the long-term picture in my view.  This is especially true if the Fed does cut rates regardless of the stronger data.

Finally, the dollar is continuing to show strength with the DXY pushing back to 103 and the euro back down near 1.09.  It seems clear the market is adjusting its views as to how much the Fed is going to cut based on the data, not the Fedspeak, and that turn, from an uber dovish Fed to one less dovish is going to support the greenback.  ZAR (+0.45%) is this morning’s outlier as it follows gold prices higher, but that is the largest movement across either the G10 or EMG blocs.  It seems everybody is awaiting the CPI data.

In addition to the CPI, we see the weekly Initial (exp 230K) and Continuing (1830K) Claims data and we hear from Gvoernor Lisa Cook, one of the more dovish Fed governors.  But for now, it is all CPI all the time.  My take is a soft number will be seen as a signal the Fed will be cutting aggressively and help stocks and commodities while undermining the dollar with a strong number doing the opposite.  Bonds, though, are much trickier here as I think there are a lot of fiscal concerns being priced in, and lower inflation won’t solve that problem in the short run.

Good luck

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A Trumpian Size

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A question on analysts’ lips
Is whether Jay can come to grips
With job growth expanding
While he was demanding
A rate cut of fifty whole bips
 
Concerns are beginning to rise
That voters will soon recognize
Inflation’s returning
And they will be yearning
For change of a Trumpian size

 

By now, I am guessing you are aware that the payroll report on Friday was significantly better than expected.  Nonfarm Payrolls rose 254K, much higher than the 140K expected, and adding to the gains were revisions higher for the previous three months of 55K.  The Unemployment Rate fell to 4.051%, rounding to 4.1%, lower than expected and another encouraging sign for the economy.  You may remember the discussion of the Sahm Rule, which claims that if the 3-month average Unemployment Rate rises 0.5% from its low in the previous 12 months, history has shown the US is already in recession at that point.  Well, ostensibly that rule was triggered two months ago, and the Unemployment Rate has now fallen 0.25% since then with a gain of over 400K jobs since then.  Those are not recessionary sounding numbers.

The upshot is that the market got busy adjusting its views with the dollar continuing to rebound against most currencies, equity markets rejoicing in the renewed growth story and bond markets getting hammered with 10-year yields rising sharply in the US (10bps Friday and 4bps more this morning) with moves higher everywhere else in the world.  In fact, this morning, European sovereign yields are also higher by between 3bps and 5bps and we saw JGB yields jump 5bps overnight.  The end of inflation story is having a tough time.

Perhaps the best depiction of things comes from the Fed funds futures markets where now there is only an 85% probability priced for a 25bp cut and a 15% probability of no cut at all.  Look at the table below the bar chart to show how much things have changed in the past week.  Jumbo rate cuts are no longer a consideration.  It will be very interesting to see how the Fed speakers adjust their tone going forward as there were many who seemed all-in on another 50bp cut as soon as next month.

Source: cmegroup.com

So, is this the new reality?  Recession is out and another up-cycle is with us?  Certainly, recent data has been quite positive as evidenced by the Citi Surprise Index, seen below courtesy of cbonds.com, which has shown a positive trend since early July.

This index is a measure of the actual data releases compared to consensus market forecasts ahead of the release.  When it is rising, the implication is that the economy is outperforming expectations and therefore is growing more rapidly than previously priced by markets.  Again, the point is the recessionistas are having a hard time making their case.  However, for the inflationistas, it is a different story.  With the employment situation improving greatly and last week’s Services ISM data showing real strength, the inflation narrative is regaining momentum.  Recall, the Fed’s rationale for cutting 50bps was that they had beaten inflation and were much more concerned about the employment situation where things seemed to be cooling.  That line of reasoning has now been called into question and the market is awaiting Powell’s answers.

Remember the time
The yen carry trade was dead?
Nobody else does!

While it may seem like this is ancient history, it was less than a month ago when the market was convinced that the yen carry trade (shorting yen to go long higher yielding assets) was dead, killed by the combination of a dovish Fed and a hawkish BOJ.  Oops!  It turns out that story may not have been completely accurate, although it was a wonderful discussion at the time.  As you can see from the chart below, the yen peaked two days ahead of the FOMC meeting, as those assumptions about both central banks reached their apex and has been steadily weakening ever since.  In fact, late last week I saw an article somewhere discussing how the carry trade was back!  The thing to understand is the carry trade never left.  It has been a popular hedge fund positioning strategy for a decade, made even more popular by the Fed’s aggressive rate hiking cycle.  While latecomers to the trade may have been forced out in the past several months, I am confident the position remains widely held.  And, based on the recent price action in USDJPY, it is growing again.

Source: tradingeconomics.com

And I believe those are the key drivers of markets this morning.  Fortunately, the Middle East situation does not appear to have gotten worse although oil (+2.6%) is trading like something is about to blow up.  The rest of the noteworthy news shows that Germany remains in a funk with Factory Orders falling sharply, -5.8%, just another indication that growth on the continent is going to struggle going forward.

Ok, let’s tour the markets we have not yet touched upon.  While Chinese markets remain closed (the holiday ended today and markets there reopen tomorrow), the Nikkei (+1.8%) continues to rebound alongside USDJPY and amid stories that new PM Ishiba has dramatically moderated his hawkish views ahead of the snap election called for the end of the month.  The Hang Seng (+1.6%) also had a strong session, with rumors of still more Chinese stimulus to be announced tonight. The combination of positive US growth news and the Chinese stimulus news helped virtually every market in Asia save India (-0.8%), which has been singing a different tune consistently.  In Europe, it should be no surprise the DAX (-0.3%) is softer, although there are some gainers on the continent (Spain +0.4%, Hungary (+0.4%) and other laggards (Norway -0.7%, Netherlands (-0.3%).  Overall, it is hard to get excited about the European scene this morning.  Alas, US futures are pointing lower this morning, down -0.5% at this hour (6:30).

We’ve already discussed the bond market and oil, but metals markets show a split this morning with gold (+0.2%) seeming to find haven support while both silver (-0.7%) and copper (-0.3%) are under modest pressure.  Remember, though, if the economic growth story is real, these metals should climb further.

Finally, the dollar is continuing its climb alongside US rates with the pound (-0.4%) the G10 laggard of note.  Most other G10 currencies are softer by a lesser amount although the yen (+0.1%) and NOK (+0.1%) are pushing slightly the other way, the former on a haven trade with the latter following oil.  The EMG bloc is more mixed with ZAR (+0.5%) actually the biggest mover as investors continue to flock toward the stock market there on the back of positivity of a change in the trajectory of the economy from the new government.

On the data front, the biggest number this week is CPI, but of real note are the 13(!) Fed speakers over 20 different venues this week.  I don’t know if I’ve ever seen that many on the calendar for such a short period.  It strikes me that they understand they need to tweak their message after the recent data.  It will be very interesting to see if they fight the data and stay the course for another cut in November or whether they walk it back completely. After all, they claim to be data dependent, and if the data points to growth, why cut?

Here is the rest of the data:

TodayConsumer Credit$12B
TuesdayNFIB Small Biz Optimism91.7
 Trade Balance-$70.4B
WednesdayFOMC Minutes 
ThursdayInitial Claims230K
 Continuing Claims1829K
 CPI0.1% (2.3% Y/Y)
 -ex food & energy0.2% (3.2% Y/Y)
FridayPPI0.1% (1.6% y/Y)
 -ex food & energy0.2% (2.7% Y/Y)
 Michigan Sentiment71.0

Source: tradingeconomics.com

And that’s how we start the week.  Whatever your personal view of the economy, the recent data certainly points to more strength than had been anticipated previously and markets are responding to that news.  For equities and the dollar, good news is good, but there seems to be a lot of time between now and Thursday’s CPI reading for attitudes to change.

Good luck

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Awakened the Beast

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The longshoreman’s union conceded
And ports will now work unimpeded
But is that enough
To make sure that stuff
Gets everywhere that it is needed?
 


Arguably, one of the biggest stories this morning is that the fears over the longshoreman’s union strike dramatically weakening the US economy while pushing up inflation have passed as there has been a temporary agreement to raise workers’ pay by 62% over the next six years although it seems that the questions over automation remain.  However, the agreement will last until January 15th, so the 3-day work stoppage is unlikely to have a major impact on the US economy, although I’m sure there will be a few hiccups around.  But hey, at least one problem is off the docket.
 
Meanwhile, problems in the Mideast
Continuously have increased
Iran took their shot
And all that it wrought
Was fear they’ve awakened the beast

Which takes us to the next major story, the nature of Israel’s response to Iran’s missile attack from earlier this week.  From what I have read, the US is trying very hard to persuade PM Netanyahu to leave Iran’s nuclear facilities and oil production capabilities alone.  While I understand the latter, given an attack there would likely drive oil prices far higher and not help VP Harris’s election prospects, I cannot understand why the US would be so adamant that Israel not seek to destroy Iran’s nuclear capabilities.  At any rate, the headline in this morning’s WSJ, “Biden Sidelined as Israel Reshapes Middle East”, seems to say it all.  At this point, we can only watch and wait.  

However, consider the benefits of either of those targets.  As it remains unclear whether Iran has achieved the capability to create nuclear weapons, an attack on those facilities, which are hardened and underground, may or may not be effective at preventing a future nuclear Iran.  But an attack on the oil production facilities, which are wide open and not nearly as well-defended, would immediately limit Iran’s income despite the certain rise in oil prices, as they would not be able to sell any.  Starving Iran of capital to continue to run its military and fund its proxies would likely be extremely effective at dramatically reducing threats to Israel.  As well, I’m pretty confident the Saudis would not be unhappy if oil rose to $90 or $100 per barrel.  My point is the latter strategy is likely to be effective at reducing Iranian activities while being quite achievable.  We shall see.

And finally, early today
The payrolls report will hold sway
O’er markets worldwide
As traders decide
If more cuts are soon on their way

Which takes us to the big economic story today, the monthly payroll report.  Wednesday’s ADP Employment data was much better than expected, showing job growth of 143K.  Current expectations are as follows:

Nonfarm Payrolls140K
Private Payrolls125K
Manufacturing Payrolls-5K
Unemployment Rate4.2%
Average Hourly Earnings0.3% (3.8% Y/Y)
Average Weekly Hours34.3
Participation Rate62.9%

Source: tradingeconomics.com

One thing to keep in mind is this is going to be the last meaningful payroll report before the next FOMC meeting because the October report, scheduled to be released on November 1st, is going to be a complete wreck with virtually no information because of the impact of Hurricane Helene.  In fact, it will likely take several months before economic data gets back to whatever its underlying trend may be given the disruption over such a wide swath of the nation.

The question of the economy’s strength continues to be a hotly contested disagreement between those who believe that a recession is coming soon, or has already started, vs. those who believe that there is no recession coming in the near future.  The first group tends to look through the headline data and sees decreasing quit rates and reduced hiring offsetting reduced firing with the lack of hiring seen as an indication business activity is slowing.  They look at high household credit card debt and growing delinquencies and see analogies to past recessions.  Meanwhile, the bulls look at the headline data and say, GDP continues to grow, inflation continues to slide and while manufacturing has been weak for nearly two years, this is a services economy and that has been strong (yesterday’s ISM Services print was a much stronger than expected 54.9).

Now, the very fact that Powell cut rates two weeks ago is indicative of the fact that there is real concern at the FOMC that growth is slowing.  I will not discuss the political question here.  But data like TSA travel clearances and restaurant seatings and the crowds at events show that at least some portion of the economy is still doing well.  Yesterday’s Claims data was 225K, a few thousand more than expected but still nowhere near a level that would indicate there is an employment glut.  

I believe the idea of the K-shaped recovery is the best description of things around.  The top quartile of income earners is doing just fine while the rest of the economy is struggling.  But that top quartile represents an outsized amount of economic activity, so the data continues to be positive.  In fact, if you are looking for a reason that there is so much angst in the electorate, this is it.  With all that in mind, though, my take is this morning’s number is going to be better than expected, somewhere on the 175K – 200K level.

Ok, let’s quickly run through market activity overnight.  Yesterday’s modest decline in US markets did not really give much direction to the overnight session as the Nikkei (+0.2%) managed to continue its recent modest rally and the Hang Seng (+2.8%) continues to benefit from a belief that Chinese stimulus is coming to the rescue.  But the rest of Asia couldn’t make up its mind (China is still closed) with gainers (Korea, New Zealand, Singapore) and laggards (India, Australia , Taiwan).  In Europe, the picture is also mixed ahead of the US data with modest gainers (CAC, DAX) and laggards (FTSE 100, IBEX) as the US data is still the key driver.  One story here is that the EU decided to impose tariffs of as much as 45% on Chinese BEV’s, something that is likely to become problematic for European exporters going forward.  As to US futures, just ahead of the data (8:00) markets are edging higher by 0.2%.

In the bond market, yields are continuing to rise around the world with Treasuries higher by 2bps this morning after a 5bp climb yesterday afternoon.  European sovereign yields are also much firmer, between 3bps and 6bps across the continent as concerns over inflation reignite.  Both the price of oil and the Chinese tariff story are driving this bond move.  As to JGB’s, they jumped 6bps last night, but that was more on the back of the US rise than any domestic news.

Oil (+1.4%) is continuing to rally as fears over an Israeli attack on Iranian assets builds.  This has helped the entire commodities complex with metals markets also firmer this morning, albeit only on the order of +0.25%. Nonetheless, the commodity higher story remains a fundamental one in my world view, especially as food prices are picking back up again around the world.  The UN’s FAO Food price index rose to its highest level in more than a year and looks for all the world like it has based and is now going to trend higher again.

Finally, the dollar is mixed this morning, with no defining theme here.  The pound (+0.35%) and MXN (+0.4%) have rallied while KRW (-0.5%) and AUD (-0.25%) have declined with the euro virtually unchanged.  My point is there is nothing specific to explain the movement.

And that’s really it.  We hear from a couple of more Fed speakers but since Powell on Monday cooled the idea of another quick 50bp cut, they have not given us much new guidance.  If I am correct and the data is strong, I expect bonds to suffer along with commodities while the dollar should gain.  Stocks are a little less clear.  However, if it is a soft number, you can be sure that the 50bp talk will dramatically increase and stocks and commodities will soar as the dollar slides.

Good luck and good weekend

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Not in a Hurry

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The committee is not in a hurry
Said Jay, but the bulls needn’t worry
‘Cause Jay knows what’s what
And he can still cut
Quite quickly and watch the bears scurry
 
Meanwhile, at all ports in the east
The longshoremen’s working has ceased
With them now on strike
We could see a hike
In costs soon with ‘flation increased

 

“Overall, the economy is in solid shape; we intend to use our tools to keep it there. This is not a committee that feels like it’s in a hurry to cut rates quickly.  Ultimately, we will be guided by the incoming data. And if the economy slows more than we expect, then we can cut faster. If it slows less than we expect, we can cut slower.”

These were the key comments by Chairman Powell yesterday at the National Association for Business Economics annual meeting in Nashville.  They were the very essence of the two-handed economist who explains both sides of an issue without drawing a conclusion.  However, it appears what the market heard was ‘the Fed’s only going to cut 25bps at a clip going forward’.  This was made evident by the fact that when he began speaking, we saw equity markets dip right away as per the chart below of the S&P 500, although as he continued, and made clear that they expected to continue to cut rates and support the economy, traders (and algorithms) decided things were fine.  

Source: Bloomberg.com

We also heard from two other Fed members, Atlanta Fed president Bostic and Chicago Fed president Goolsbee, who both explained 50bps could well be the appropriate next move if things don’t follow their current script perfectly.  Naturally, equity markets heard that news and were soothed, hence the result that all three major indices closed slightly higher on the day.

The other major story this morning is that the International Longshoreman’s Association, the union for dockworkers along the entire East Coast and Gulf of Mexico, have gone on strike as of midnight.  They are demanding a 77% increase in wages over the next 6 years as well as promises about the speed with which further automation will occur in order to save jobs.  While the Taft-Hartley act could be invoked by the president to force both sides back to the bargaining table and require the workers to get back on the job for the next 80 days, President Biden has chosen not to do so in an effort to polish his political bona fides with unions.

The ultimate impact of the strike will depend entirely on its length.  This was not a surprise and many retailers and other importers pre-ordered inventory to tide them over as the holiday shopping season gets going.  However, estimates range up to an economic cost of $5 billion per day for each day of the strike, and the longer it goes on, the bigger the problem because rescheduling once things are settled will be that much more complex.  Regardless of the timing, though, one can be pretty certain that this will pressure prices higher as either shortages of certain items develop, or the wage gains result in higher shipping costs which will almost certainly be passed through the value chain.  

Remember, while headline PCE fell to 2.2% last month, core remained at 2.7%.  In the CPI readings, headline is still 2.5% with core at 3.2%, and perhaps more disconcertingly, median CPI at 4.2%.  Powell’s decision to cut rates 50bps last month with GDP still growing at 3%, the Unemployment Rate at a still historically low level of 4.2% and inflation, whether measured as PCE or CPI well above 2.0% was quite aggressive.  If this strike lasts a while, more than one week, expect to see price pressures begin to build again and that is going to put the Fed in a very difficult position.

One last thing to consider is the fact that virtually every major central bank around the world is in easing mode now that the Fed has begun to cut despite the fact that growth remains in decent shape in most places (Germany excepted).  This morning’s Eurozone CPI data (1.8%, 2.7% core) was even softer than expected virtually guaranteeing more aggressive action by the ECB and of course the PBOC was hyperaggressive last week in their easing actions.  Yesterday, Banxico indicated they may begin to cut more aggressively after having started their easing stance with 25bp cuts, as inflation in Mexico continues to decelerate to their target level of 3% +/- 1%.  The point is that policy worldwide is easing, or even in the few places where it is not, e.g. Japan and Australia, they are not tightening at any great pace.  The upshot is there is greater scope for a rebound in inflation while the dollar and other currencies continue to devalue vs. real items like commodities and real estate.  That is another way of saying that prices in those two asset classes should continue to climb.  As to the fiat currency world, relative values will depend on the pace with which individual nations ease, but they will all sink over time.

So, how have markets responded to the latest news?  After the modest US gains yesterday, and remember China is closed all week, Japan (+1.9%) regained about half of Monday’s declines after Ishiba-san was officially named PM and he appointed and Abenomics veteran, Katsunobu Kato, as his FinMin, helping encourage the idea that the BOJ may not be quite as aggressive as previously thought.  The rest of Asia saw more gainers than laggards with Taiwan (+0.75%) the next best performer and a mix otherwise.  In Europe, the picture is mixed with some gainers (FTSE 100 +0.4%, DAX +0.3%) and some laggards (IBEX -0.6%, CAC -0.2%) after Manufacturing PMI data across the continent continued to show lackluster results with Germany falling even further to a reading of 40.6 although Spain’s reading jumped to 53.0.  I must admit the stock market outcomes seem backward although I can understand the German view that the ECB will be more aggressive, thus supporting stocks, but why that is not helping Spain is a mystery.  As to US futures, at this hour (7:20) only the DJIA (-0.35%) is showing any discernible movement.

In the bond market, after yields backed up 5bps yesterday over concerns that the Fed’s more aggressive stance would lead to inflation and the port strike would not help that situation, they are sliding this morning.  Treasury yields, after touching 3.80% during yesterday’s session are down to 3.74% this morning and European sovereign yields have fallen even more sharply, between -7bps (Germany) and -12bps (France) as traders and investors become convinced that the ECB is going to become more aggressive in their easing.  JGB yields also slid 1bp last night after Kato-san’s appointment.

It should be no surprise that metals prices are rebounding this morning given the decline in yields as well as the growing concerns over inflation.  So, gold (+0.5%) is leading the way higher but the entire group is higher on the session.  However, oil (-0.8%) remains under pressure as news of Israel’s ground incursion into Lebanon to root out Hezbollah seem to be ignored while news that Libya is getting set to restart production after a political settlement was reached there adds to the supply picture.  

Finally, the real surprise is the dollar, which based on yields and metals would have been expected to continue sliding, but instead has rebounded sharply.  In fact, yesterday, the DXY rallied virtually all day and that has continued this morning with the index now above 101.00.  You may recall I highlighted that it was testing the 100 level which is seen as a key support.  I guess there is no break coming today.  This morning, the dollar’s move is universal, rising versus both the euro (-0.5%) and pound (-0.5%) as well as the rest of the G10 save the yen which is unchanged on the day.  In fact, 0.5% is the magnitude of that move virtually all the other currencies in the bloc.  As to the EMG bloc, these currencies have also suffered by -0.5% or so regardless of the region with the CE4 the worst performers, averaging -0.7%, while Asian currencies were down more on the order of -0.3% and LATAM -0.5%.

On the data front, ISM Manufacturing (exp 47.5) and JOLTS Job Openings (7.655M) are the main features and we hear from four more Fed speakers (Bostic, Cook, Barkin and Collins) before the day is done.

It is hard for me to look at the current situation without growing concern that the Fed is in the process of making a catastrophic error by easing policy into the base of an inflation cycle that just got more impetus from a key labor situation.  In the end, it is not clear to me how the dollar will behave against other currencies in the short run, but I see only upside for commodity prices.  If things do get ugly, the dollar will be seen as the best of a bad lot, and as commodity demand grows, so will demand for the greenback in order to buy those commodities, but this is not a positive story.

Good luck

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A Brand New Zeitgeist

Posted on by

Although it’s the number two nation
Of late its shown real desperation
Seems Xi did appraise
The recent malaise
And ordered growth maximization
 
So, mortgage rates there have been sliced
And refi’s are now getting priced
It’s different this time
The bulls, in sync, chime
As Xi seeks a brand new zeitgeist

 

As China gets set to head off for a week-long holiday, President Xi wanted to make sure everybody there felt great and would start to spend money again.  His latest move came via the PBOC where they loosened the regulations regarding refinancing of home mortgages, now allowing them for everybody starting November 1st.  The key housing rate in China is the 5-year Loan Prime Rate, and while that has fallen steadily over the past two years, down nearly 1%, all the people who were swept up in the property bubble that began to burst three years ago have not been able to take advantage of the lower rates.  This is what is changing, and I presume there will be quite a bit of refi activity for the rest of the year.

So, to recap what China has done in the past week, they have cut interest rates across the board, guaranteed loans to be used for stock repurchases, changed regulations to allow lower down payments on mortgages for first and second homes and now allowed more aggressive refinancing of existing mortgages.  As well, they reduced the RRR, freeing up capital for banks, and relaxed rules for regional governments to be able to spend more.  Now matter how this ultimately ends up, you must give Xi full marks for finally figuring out that in a command economy, he needed to command some more stimulus.  The latest mortgage news has simply excited the equity market even more and there was another huge rally last night (CSI 300 +8.5%), which when looking at a chart of that index shows an impressive rally in the past two weeks, slightly more than 27%!

Source: tradingeconomics.com

However, before we get too carried away, a little perspective may be in order.  The below chart is the 5-year view, and while the recent rebound is quite impressive, it simply takes us back to the level from July 2023 and remains more than 30% below the highs seen in February 2021.  I might argue that even if all of these policies work out as planned, something which rarely ever happens, until the economic data start to prove it out, things here feel a bit overbought for now.  Putting an exclamation on the last point, last night China released its monthly PMI data which showed just why Xi has become so aggressive.  Every reading, from both Caixin and the National Bureau of Statistics, was weaker than last month and weaker than expected.  Xi certainly needed to do something.

Source: tradingeconomics.com

Gravity remains
An unyielding force, even
For Japanese stocks

Now, a quick mea culpa from Friday’s note as I was in error on my analysis of the Japanese stock market in the wake of the election of Ishiba-san.  It seems that the announcement of his victory was not made until after the cash equity market was closed for the day. At that time, Sanae Takaichi remained the odds-on favorite to win the vote, and the market was anticipating a more dovish approach to things. Hence, the idea of the return to Abenomics and a much slower policy tightening was welcomed by the equity market at the same time the yen weakened.  But with Ishiba-san’s surprise victory, all of that got tossed out the window.  

Of course, USDJPY was able to respond instantly, hence the sharp reversal in the market I showed in a chart on Friday.  However, the futures market sold off sharply on the election news and now that has been reflected in the overnight session with the Nikkei (-4.8%) giving back all the gains it had made in the previous two sessions in anticipation of a dovish turn.  So, as you can see in the below chart for the Nikkei 225 over the past week, we are basically exactly where things started before the Takaichi expectations built.  Truly much ado about nothing.

Source: tradingeconomics.com

As to the rest of the overnight session, beyond the Chinese data, we saw German state CPI readings which continue to fall as the German economy continues to slow appreciably.  We also saw UK GDP data, which was slightly softer than forecast, although at 0.9% Y/Y, still well ahead of Germany’s pace.  But otherwise, not very much else.  Last Friday’s PCE data was largely in line and quite frankly, most of the market seems to be focused on China right now, not the US, as that has become the newest idea on how to get rich quick.

So, here’s a quick recap of the session thus far.  Away from China and Japan, we saw more weakness than strength in Asia with both Korea and India falling more than -1.0%, although the rest of the region was mixed with much smaller moves.  Australia (+0.8%), though, benefitted from the China story as the price of iron ore, one of its major exports, rose 11% overnight on the idea that Chinese construction was coming back.  However, European bourses are under pressure this morning led by the CAC (-1.6%) with the rest of the continent also soft on the back of weaker earnings forecasts and announcements from European companies.  As to US futures, at this hour (7:20), they are pointing lower by -0.25%.

In the bond market, with all the excitement over renewed growth in China and continued tightening in Japan, yields are backing up slightly with virtually every G10 government seeing yields higher by 2bps this morning.  Ultimately, for Treasuries my fear is with the Fed cutting rates now and no real sign that the economy is slowing rapidly, we are going to see a quicker rebound in inflation than they are anticipating and that will not help the long end of the curve at all.

In the commodity markets, we are following Friday’s declines with further moves lower this morning as oil (-0.55%) continues to struggle on the weak demand story (this time from Europe, not China) while metals markets are also under pressure with all three biggies down (Au -0.75%, Ag -1.4%, Cu -0.7%).  This is a bit confusing for two reasons.  First, with the euphoria that the Chinese reflation story has generated, I would have expected copper to continue to rally alongside iron ore, but second, the dollar is softer today, and that generally supports the metals markets.

So, a quick look at the dollar shows the DXY is looking to test 100.00, a level it last briefly touched in July 2023 but spend most of 2020 and 2021 below.  This is concurrent with the euro (+0.3%) testing 1.12 and the pound (+0.3%) testing 1.35, with the former showing virtually the same pattern as the DXY and the latter making new highs for the past two years.  But there is some schizophrenia in the G10 with JPY (-0.2%), CHF (-0.3%), NOK (-0.35%) and SEK (-0.2%) all under pressure today.  While NOK and SEK make sense given the commodity moves, that doesn’t explain gains in AUD and NZD.  Some days are just like that.  In the EMG bloc, in truth, the dollar is showing more strength than weakness with ZAR (-0.35%), CNY (-0.2%) and KRW (-0.15%) although MXN (+0.3%) is bucking that trend.  On the one hand, it is quite confusing to see so many contrary moves amongst the currencies that typically track closely together.  On the other, though, none of the moves are very large, so there can be idiosyncratic explanations for all of this without changing the big picture story.

On the data front, we get a bunch of stuff culminating in NFP on Friday.

TodayChicago PMI46.2
 Dallas Fed Manufacturing-4.5
TuesdayISM Manufacturing47.5
 ISM Prices Paid53.7
 JOLTS Job Openings7.67M
WednesdayADP Employment120K
ThursdayInitial Claims220K
 Continuing Claims1837K
 ISM Services51.6
 Factory Orders0.1%
FridayNonfarm Payrolls140K
 Private Payrolls120K
 Manufacturing Payrolls-5K
 Unemployment Rate4.2%
 Average Hourly Earnings0.3% (3.8% Y/Y)
 Average Weekly Hours34.3
 Participation Rate62.9%

Source: tradingeconomics.com

As well as all that, we hear from nine different Fed speakers over 13 different speeches this week, including Chairman Powell this afternoon at 2:00pm.  It’s not clear that we have learned enough new information for Powell to change his tune although given all of China’s moves there could be some belief that the Fed doesn’t need to be so aggressive.  Now, as of this morning, the Fed funds futures market is pricing a 41% probability of a 50bp cut in November and a 50:50 chance of a total of 100bps by the end of the year.  but, if China is easing so aggressively, does the Fed need to as well?

Right now, the story is all China.  However, I still detect a lot of positive sentiment in the US and expectations that the Fed is going to continue to ease and boost growth, inflation be damned.  It still strikes me that you cannot be bullish both stocks and bonds here as they are going to respond quite differently to the future.  As to the dollar, it is clearly on its back foot as the pricing of further Fed ease undermines it for now, but remember, as other central banks follow the Fed more aggressively, any dollar declines will be muted.

Good luck

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A Financial Home Run

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Seems President Xi isn’t done
And last night he added a ton
Of new stimuli
In order to try
To hit a financial home run
 
The market response has been clear
Forget anything that’s austere
It’s buy with both hands
Ere Powell rebrands
QE as just more Christmas Cheer

Things are obviously worse in China than President Xi had been willing to let on for the past several months/years, as after two straight days of monetary policy stimulus announcements, they pulled out the big guns and got the fiscal side of the process involved.  Last night the Politburo pledged further support after a surprise meeting to discuss economic policies.  Their economic discussions have historically only occurred in April, July and December, so this was the latest indication that Xi is really concerned. 

Some of the actions include an (unspecified) effort to make the real estate market “stop declining”, limiting construction of new home projects, issuing CNY 2 trillion of special sovereign bonds to disburse funds to help fund financial assistance for low-income workers, shore up bank capital to encourage more lending and support further investment in productive capacity as well as to potentially buy up unfinished homes.  

Obviously, Xi was quite concerned that the country would not achieve his 5% GDP growth target for 2024 as an increasing number of analysts around the world were penciling in slower growth, and he decided he could not wait until December for the next policy adjustments.  Remember, too, that next week is a week-long Chinese holiday, so part of the impetus was to give cash to people to encourage more spending/activity.  While it is far too early to determine how effective these new policies will be at supporting real, organic economic activity, they did wonders for equity markets and risk assets around the world.

And really, that continues to be the main story.  With the Fed now having confirmed that lower rates are appropriate, I would look for almost every nation to boost stimulus, both monetary and fiscal, especially in the wake of recent election results which have seen incumbent after incumbent tossed from office.  After all, what good is being in power if you cannot buy your way to re-election?

So, how has all this impacted financial markets this morning?  You will not be surprised to see that risky assets are in huge demand with equity markets rallying everywhere along with metals, while haven assets see much more modest demand, with bond yields having slipped just a bit lower.

Yesterday’s mixed US market performance is but a distant memory this morning with Asian shares roaring higher (Nikkei +2.8%, Hang Seng +4.2%, CSI 300 +4.2%) and gains virtually across the region, albeit not quite as robust as those.  But after the Fed cut, this fiscal stimulus from China is seen as helping everybody.  Europe, too, is rocking this morning with gains well above 1.0% everywhere (DAX +1.2%, CAC +1.6%, IBEX +1.1%) except the UK (FTSE 100 +0.2%) which continues to struggle as the Labour government is shown to be further and further out of its depth with respect to actually running things rather than carping about how the Tories did it.  And not to worry, US futures are all racing higher as well this morning, higher by between 0.3% (DJIA) and 1.5% (NASDAQ) at this hour (7:15).

In the bond market, Treasury yields have edged lower by 2bps and remain far below the Fed funds rate.  It is not clear if this is the market anticipating a more significant economic slowdown or simply a continued manifestation of the fact that the Fed still owns a significant portion of the debt outstanding and so has restricted supply at the margin.  In Europe, yields are also lower, with the riskiest nations seeing the biggest declines as risk assets are in vogue this morning.  Thus, Italy (-7bps) and Greece (-6bps) have moved the farthest, but otherwise we are seeing movement on the order of -3bps elsewhere.  In another quirk, and a telling comment on the state of France’s finances, Spanish 10yr bonos now yield less than French 10yr OATs for the first time in more than 15 years.

Turning to commodities, oil (-2.8%) didn’t get the China rebound memo and has tumbled nearly $2/bbl falling well below the $70/bbl level.  It seems that Saudi Arabia is dropping its price target and preparing to increase production, something the market has been fearing.  As well, in Libya, which had not been producing lately due to political issues, it appears a tentative agreement is in place that will allow for more supply on the market.

But you know what really benefits from a lot of deficit spending and the effective abandonment of inflation targets?  That’s right, precious metals as gold (+0.8%) continues its steady move higher to new all-time highs and quickly approaches $2700/oz.  This has taken both silver (+2.2%) and copper (+2.2%) along for the ride and there is currently no end in sight.

Finally, the dollar is under pressure this morning in a classic risk-on reaction.  AUD (+0.9%) is the leading G10 gainer on the back of its strong metals exposure while NZD (+0.8%) is right behind.  But the dollar’s weakness is manifest in Europe (EUR +0.2%, GBP +0.5%, SEK +0.5%) as well as against most EMG currencies.  In fact, CNY (+0.55% and below 7.00) is one of the biggest movers today although we are seeing strength in KRW (+0.7%), MXN (+0.5%) and ZAR (+0.4%), an indication that this move is widespread.  As long as the perception remains that the Fed is going to lead the way to lower interest rates, I can see the dollar underperforming.  However, as soon as we see other nations become more aggressive, this move will abate.

On the data front, there is much on the calendar this morning starting with the weekly Initial (exp 225K) and Continuing (1832K) Claims data as well as the 3rd look at Q2 GDP (3.0%).  We also see Durable Goods (-2.6%, +0.1% ex-Transports) and then the ancillary data that comes with the GDP report including Real Consumer Spending (2.9%), Final Sales (2.2%) and the GDP PCE indicator (2.5% headline, 2.8% core).  But perhaps of far more importance, we hear from a host of Fed speakers this morning.  Governor Kugler and Boston Fed president Collins speak about financial inclusion, Governor Bowman discusses the economy and monetary policy, Governor Cook discusses AI and workforce development, Vice-chair Barr discusses regulation and Chairman Powell gives the opening remarks at the US Treasury Market Conference in NY. 

Yesterday, Governor Kugler added to the ‘mission accomplished’ view on inflation at the Fed and lauded the move to focus on Unemployment.  I would contend this is the key issue right now, the fact that central banks around the world, but particularly the Fed, have determined that the inflation fight is over.  While we may very well touch 2.0% core PCE in the next months, it strikes me as highly unlikely that level will be maintained.  Rather, 2.0% is now the floor and if the Unemployment Rate behaves in its historic manner, accelerating higher now that it has started to move in that direction, look for much sharper interest rate cuts, much higher inflation and a much weaker dollar.  To me, that is the biggest risk.  However, if Unemployment follows the Fed’s projected path, and stays quiescent, then the current slow decline in rates and a very gradual decline in the dollar seems more likely.

Good luck

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Recalibration

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All week we had heard many clues
That fifty is what Jay would choose
And that’s what he cut
With only one but
From Bowman, who shuns interviews
 
The key is now recalibration
In order to tackle inflation
Without driving higher
The joblessness spire
So, trust us, it’s all celebration

 

“Recent indicators suggest that economic activity has continued to expand at a solid pace. Job gains have slowed, and the unemployment rate has moved up but remains low. Inflation has made further progress toward the Committee’s 2 percent objective but remains somewhat elevated.” [emphasis added]

Reading the opening paragraph of the FOMC Statement, it might be confusing as to why they needed to cut rates 50bps.  After all, the economy is expanding at a solid pace (In fact, after the Retail Sales data on Tuesday, the Atlanta Fed’s GDPNow reading for Q3 is up to 3.0%!)  unemployment remains low and inflation is still somewhat elevated.  I know I am a simple poet, but the plain meaning of those words just doesn’t lead my thinking to, damn, we better cut 50 to get started.  But I guess that is just another reason I am not a member of the FOMC.

Perhaps the more interesting thing was the Summary of Economic Projections and the dot plot which showed that while expectations were for rates to fall far more dramatically than in June, the longer run expectations continue to rise.  In fact, Chairman Powell specifically addressed the SEP in the press conference, “If you look at the SEP you’ll see that it’s a process of recalibrating our policy stance away from where we had it a year ago when inflation was high and unemployment low to a place that’s more appropriate, given where we are now and where we expect to be, and that process will take place over time.” [emphasis added] In fact, there was a lot of recalibrating going on as that appears to be the Chairman’s new favorite word, using it 8 times in the press conference.

Source: federalreserve.cgov

Notice that their current forecasts are for GDP to slow to 2.0% with Unemployment edging only slightly higher while PCE inflation magically returns to their 2.0% target.  And take a look at the last two lines, with the Fed funds rate projections falling substantially for the next three years, far more quickly than their previous views, although they think the long-run level will be higher.  

I wonder about that last issue.  Historically, the thought was that the long run Fed funds rate would be inflation (2.0%) + real interest rate (0.5%) and they pegged it at 2.5% for years.  Now that they see it at 2.9%, is that because they think inflation is going to be higher (not according to their projections) which means that for some reason they think real interest rates are going to be higher.  However, when asked, Chairman Powell and every member of the board has been unable to explain this change.

But what really matters is how have markets responded to this earth-shattering news?  The initial movement was as expected, with stocks rallying sharply (see chart below) and yields sliding along with the dollar while commodities rallied.

Source: Bloomberg.com

But a funny thing happened on the way to the close, as can be seen in the chart.  Stocks gave back all their gains and then some, with all three major indices lower on the session while 10yr Treasury yields backed up 7bps and the dollar rebounded.  Arguably, this was a sell the news response, but we need to be careful.  Remember, there are many analysts who believe the economy is in deep trouble already and by starting off with a big cut, those with paranoia may be wondering what the Fed knows that the data, at least the headline data, is not really showing.

So much for yesterday, now let’s look at markets this morning beyond the initial knee-jerk responses.  Absent any other major news or data (Norgesbank leaving rates on hold doesn’t count as major), markets have played out far more along the lines of what would have been expected in the wake of a 50bp cut.  In other words, the dollar has fallen sharply against almost all its counterparts, equity markets have rallied around the world, commodity prices have rallied sharply, and bond yields are…unchanged? 

Which brings us to the question that has yet to be answered.  Which market is right, stocks or bonds?  They appear to be telling us different stories with stocks pushing to new highs amid rising multiples and rising profit growth expectations while bonds are pricing in another 200bps of rate cuts by the end of 2025, an outcome that would only seem to make sense in the event the economy fell into a recession.  But if we are in a recession, corporate earnings seem highly unlikely to rise as much as currently forecast and typically, P/E multiples contract.  Meanwhile, if the economy is humming along such that current equity pricing is warranted, what will be the driver for the Fed to cut rates as that will almost certainly reignite inflation.  

History has shown that the bond market tends to get these big questions right when they are pointing in different directions, but that doesn’t mean that risk assets will stop rallying right away.  In fact, this will likely take quite a while to play out.

Ok, so let’s put a little more detail on the market activity overnight.  Tokyo rocked (+2.0%) as did Hong Kong (+2.0%), Taiwan (+1.7%), Singapore (+1.1%) and even mainland China (+0.8%) managed to rally some.  It appears that investors around the world believe the Fed has opened the floodgates for a much lower interest rate environment everywhere.  European bourses, too, are sharply higher led by the CAC (+2.1%) but with strength across the board (DAX +1.5%, FTSE 100 +1.3%).  And US futures have shaken off the late selloff yesterday and are firmly higher this morning led by the NASDAQ (+2.2%).

Bond yields, though, are largely unchanged on the day, with yesterday’s backup in Treasury yields maintained and European sovereigns all within 1bp of yesterday’s close.  It appears that bond investors are less confident in a soft landing than equity investors.  Interestingly, JGB yields rose 2bps last night as Japanese markets prepare for the BOJ meeting tonight.

In the commodity markets, oil (0.75%) is continuing its recent rebound after another massive inventory draw was revealed by the EIA yesterday prior to the Fed meeting.  There is a growing concern that inventories in Cushing, Oklahoma are falling to a point where products like gasoline and diesel will not be able to be produced.  As an example, gasoline futures have risen far more than crude futures this week on that fear.  As to the metals markets, gold briefly touched $2600/oz yesterday immediately in the wake of the FOMC but sold off hard afterwards.  This morning, however, it is back pushing up to that level again and the entire metals complex is rising nicely.

Finally, the dollar, has been a whipsaw of late.  Post the FOMC, it fell sharply across the board, and then into yesterday’s close it rebounded to close higher on the day.  However, this morning it has given back all those late gains and then some, and is now sitting at its lowest level, at least per the DXY, since April 2022.  This morning, in the G10, we are seeing many currencies rally between 0.5% (EUR) and 1.3% (NOK) vs the dollar and everywhere in between.  The one exception to that is the yen (-0.2%) which is biding its time ahead of the BOJ meeting.  The working assumption is that the BOJ will do nothing tonight, but now that the Fed has cut 50bps, and given Ueda-san’s history of actively trying to surprise markets to achieve outcomes he wants, we cannot rule out another rate hike in Japan.  Monday morning, USDJPY fell below 140 for the first time in 18 months.  My take is Ueda-san is quite comfortable with it heading back to the 130 level, if not the 120 level.  If he were to surprise markets and raise the base rate by even 10bps tonight, I think we would see a sea change in sentiment and a much lower dollar.  And given inflation in Japan seems to have stalled at 2.8%, well above their 2.0% target, he has a built-in excuse.

Too, watch the CNY (+0.45%) as it is now trading at its highest level (weakest dollar) in more than a year, and is approaching the big, round number of 7.00.  the linkage between JPY and CNY is tight as they constantly compete in markets, especially now in autos and electronics.  If the Fed is really going to cut as much as markets are pricing, both these currencies should strengthen much further.

It is almost anticlimactic to discuss the data today but here goes.  First, the BOE left rates on hold, as expected and the market impact was limited.  Expectations are they will cut next in November.  As to data, we see Initial (exp 230K) and Continuing (1850K) Claims, Philly Fed (-1.0) and Existing Home Sales (3.90M).  None of that is likely to change any views.  Prior to the BOJ meeting, at 7:30 this evening we see Japanese CPI, which may change views there.

For now, the dollar is very likely to remain on its back foot as enthusiasm builds for multiple rate cuts by the Fed going forward.  However, if the data continues to impress like it has lately, that enthusiasm will need to be tempered.

Good luck

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